MONOPOLISTIC COMPETITION, OLIGOPOLY,

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MONOPOLISTIC COMPETITION, OLIGOPOLY, GAME THEORY
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MONOPOLISTIC COMPETITION

• Firms in monopolistically competitive industry
  share some of the characteristics of perfect
  competition market structure
• Presence of many firms.
• Availability of complete information
• Freedom of exit and entry

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MONOPOLISTIC COMPETITION

• But unlike Firms in perfect competition industry,
  monopolistically competitive industry firms share
  one unique characteristic
• Products are not homogenous. Each firm produces a
  product that differs in some slight way from the
  products of its competitors.

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MONOPOLISTIC COMPETITION

• But competitors products are close substitutes,
  therefore in this market structure, firms do have
  real monopoly power.
• Example of monopolistic competition firms gas
  stations, dry-cleaning services, etc.

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MONOPOLISTIC COMPETITORS DEMAND CURVE

• Due to the presence of substitutes for
  monopolistic firms products, but not perfect
  substitutes
• Demand curve is downward sloping.

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REVENUE CURVES FOR MONOPOLISTIC FIRM

• Monopolistic firms are assumed to maximize their
  profits.
• So, the relationship between MC and MR determines
  the optimal quantity of output.
• Demand curve determines the price at which output
  will be sold.

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REVENUE CURVES FOR MONOPOLISTIC FIRM

• Because product differentiation, a monopolistic
  firm could alter the price of its product to
  affect the quantity of output sold.
• But the price alteration is limited by the
  existence of close substitutes.
• So, monopolistic firm price PgtMR

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REVENUE CURVES FOR MONOPOLISTIC FIRM

• A firms demand curve is equivalent to its AR
  curve.
• Monopolistic firms demand curve is
  downward-sloping, the MR curve lies below it.
• Remember When the average is falling, the
  marginal is below the average.

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PRICE AND MARGINAL COST

• As seen, monopolistic firms price, PgtMR.
• Monopolistic firm produces output at which MRMC
• Thus, monopolistic firm must produce at a level
  of output at which PgtMC.
• Monopolistic firm does not exhibit resource
  allocative efficiency (P?MC).

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SHORT-RUN PROFIT MAXIMIZATION

• Profit-Maximizing Output Additions to firms
  profit are positive as long as the MR received
  from the sale of an additional unit of output
  exceeds the MC incurred in producing that unit.

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SHORT-RUN PROFIT MAXIMIZATION

• Profit-Maximization price The MR curve used to
  determine profit maximizing output is based on
  the firms demand curve. MR captures the firms
  revenues of selling various levels of output at
  the corresponding prices on the demand curve.
  Thus, to find the equilibrium price, find the
  point on the demand curve directly above the
  profit-maximizing output.

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LONG-RUN PROFIT MAXIMIZATION

• Effects of entry on the monopolistic firm as
  new firms enter, the demand curves for existing
  firms shift inward
• Given the relationship between MR and Demand, MR
  also shifts inward
• Thus, the inward shift in the Demand results in
  lower levels of AR, which leads to a profit
  declines.

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LONG-RUN PROFIT MAXIMIZATION
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LONGT-RUN PROFIT MAXIMIZATION CHARACTERISTICS

• Excess Capacity Theorem profit maximizing
  output is at the point of tangency between Demand
  curve and AC. This level output is to the left
  of the output level corresponding to minimum AC.
  The difference between these two output levels is
  known as excess capacity.

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EXCESS CAPACITY
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OLIGOPOLY

• Few sellers and many buyers
• Firms produce either homogenous, or
  differentiated products
• There are barriers to entry
• Concentration ratio the percentage of industry
  sales accounted for by x number of firms in the
  industry. Note, high concentration implies few
  sellers.

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OLIGOPOLY

• Few sellers and many buyers
• Firms produce either homogenous, or
  differentiated products
• There are barriers to entry
• Concentration ratio the percentage of industry
  sales accounted for by x number of firms in the
  industry. Note, high concentration implies few
  sellers.

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PRICE AND OUTPUT UNDER OLIGOPOLY

• Cartel Theory
• Kinked Demand Curve Theory
• Price Leadership Theory.

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THE CARTEL THEORY

• A cartel exists when collusive behavior between
  oligopolists takes the form of written agreements
  or other formal arrangements regarding output
  price and quantity.
• So doing, oligopolists act as if there were only
  one firm in the industry.
• Thus, a cartel can reduce output and increase
  price in an effort to increase joint profits.

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THE CARTEL THEORY
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The Benefits of Being Members of a Cartel

• We assume the industry is in long-run
  equilibrium, producing Q1, and charging P1.
  There are no profits. A reduction in output to
  QC through the formation of a cartel raises price
  to PC and brings profits of CPCAB

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THE CARTEL THEORY

• Problems with cartel
• Formation each potential member has an
  incentive to be a free rider.
• Formulation of Cartel Policy there may be as
  many policy proposals as there cartel members.
• Entry high profits provide incentives for new
  suppliers to join the Cartel. The Cartel is
  likely to break up if new members enter.
• Cheating Cartel members have incentive to cheat
  on the agreement

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THE CARTEL THEORY
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THE KINKED DEMAND CURVE THEORY

• The key behavioral assumption is that if a single
  firm lowers price, other firms will do likewise,
  but if a single firm raises price, other firms
  will not follow suit.

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The Kinked Demand Curve Theory

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Observations About Kinked Demand Theory

• Prices are sticky if oligopolistic firms face
  kinked demand curves.
• The kinked demand curve posits that prices in
  oligopoly will be less flexible than in other
  market structures.

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Price Leadership Theory

• One firm in the industry, called the dominant
  firm, determines price and all other firms take
  this price as given.
• The dominant firm sets the price that maximizes
  its profits, and all other firms take this price
  as given.
• All other firms are seen as price takers. They
  will equate price with their respective marginal
  costs.

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THE PRICE LEADERSHIP THEORY
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Game Theory

• Is a mathematical technique used to analyze the
  behavior of decision makers who
• Try to reach an optimal position through game
  playing or the use of strategic behavior.
• Are fully aware of the interactive nature of the
  process at hand.
• Anticipate the moves of other decision makers.

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Prisoners Dilemma
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Cartels and Prisoners Dilemma
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Theory of Contestable Markets

• There is easy entry into the market and costless
  exit from the market.
• New firms entering the market can produce the
  product at the same cost as existing firms.
• Firms exiting the market can easily dispose of
  their fixed assets by selling them elsewhere.